A Note To Entrepreneurs In A Production Business
By Alvin Mason
Entrepreneurs in a business with production as a major part of operations, you need to understand that production of any type only moves as fast as the slowest person or process. The slow point can create bottleneck as the production process must wait for the goods in process to be completed at the slow point. This creates lag time throughout the rest of the assembly or production process.
The causes of the slow point can be a person or a process.
If the bottleneck is caused by a slow person than it may be necessary to hire and train another person for that process. In production there are some stations where one person can adequately handle production, but there are situations in production where additional people are needed at a station.
If the bottleneck is caused by a slow point in the process, for example if all products must go through a machine process and that is the slow point of production than it might be necessary to purchase or lease another machine.
When determining to hire additional workers or purchase or lease another machine you should perform a breakeven analysis. To perform a breakeven analysis you must understand fixed cost and variable cost.
The formula would be Sales = variable expenses + fixed expenses
Fixed Cost are constant and remain the same no matter what quantity of goods or services are produced. Fixed cost cannot be avoided and might include such things as rent and managers salaries. Fixed cost are also classified as indirect cost.
Variable Cost are cost that change in relation to some business activity. Such things as production, sales volume, and labor hours can affect variable cost.
With production there is the cost of materials, labor and overhead. Overhead is all other cost that are not for materials or labor. Such things as administrative cost, utilities, and supplies are overhead.
If you purchased or leased a machine than you would include that expense in your fixed cost unless the lease agreement has fixed plus volume or usage cost. With the purchase the cost would be capitalized and expensed as depreciation over the useful life of the machine. That expense would be part of fixed cost.
In an accounting period if the sales price is $100.00 per unit and the fixed cost is $15,000 per period including the cost of the new equipment and the variable cost per unit is $25.00 the breakeven analysis is as follows:
Breakeven Point in the Production of One Product
If the variable expenses per unit are $25.oo we will list that at 25X
If the total fixed expenses are $15,000.oo per period then we use that in the formula.
If the sales price is going to be $100.oo per unit then we use 100X
The formula is $100X=$25X + $15,000 or 75X = 15,000
15,000 / 75 = 200 The breakeven point is 200 units selling at $100.oo.
If you hired an additional worker at say $20.00 per hour, you would multiply the number of hours times the rate ($20.oo) in the period, then add that total to fixed cost. However labor can be a variable cost.
There are many breakeven point examples on the internet.
One last thought, all people should be crossed trained. So a worker at one station can help reduce the bottleneck at another station. Should a worker not come to work production can still take place.